Fiscal reaction function and fiscal fatigue: evidence for the euro area

Cristina Checherita-Westphal and Václav Žďárek
Authors registered in the RePEc Author Service: Cristina Checherita Westphal

No 2036, Working Paper Series from European Central Bank

Abstract: This paper estimates a fiscal reaction function (FRF) framework for euro area countries and derives a novel approach to measure fiscal fatigue. As in previous studies, we find evidence that euro area sovereigns abide, on average, by (weak) sustainability constraints. The primary balance improves by about 0.03–0.05 for every 1 percentage point increase in the debt-to-GDP ratio after controlling for other relevant factors. The positive reaction of primary surpluses to higher debt strengthened over the crisis. Based on this framework, we propose a simple, practical measure of fiscal fatigue that can be used to assess the capacity of sovereigns to maintain primary surpluses over extended periods of time. This measure can be derived by comparing simulated primary balance paths in the context of debt sustainability analyses with countries’ track-record, adjusted for the change in debt with the estimated fiscal reaction coefficient. The evidence of fiscal fatigue in non-linear FRF specifications is weaker for our euro area sample. JEL Classification: H60, E62, F41, C33

Keywords: debt sustainability; euro area; financial crisis; fiscal fatigue; fiscal reaction function (search for similar items in EconPapers)
Date: 2017-03
New Economics Papers: this item is included in nep-eec
Note: 1790315
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Citations: View citations in EconPapers (38)

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